Question

If+mortgage+rates+rise+from+5%+to+10%+but+the+expected+rate+of+increase+in+housing+prices+rises+from+2%+to+9%,+are+people+more+or+less+likely+to+buy+houses?

Answer 1

People are more likely to buy houses

compute real interest rates (r = i - π) in both periods:

Before r = 5% - 2% = 3%

After r = 10% - 9% = 1%

Because the real interest rate that must be paid has decreased from 3% to 1%, more people are now likely to buy homes. The amount of money that people are paying back may be increasing, but because property prices have increased so quickly, the actual cost of financing homes has decreased. The real interest rate for acquiring a home has decreased from 3% (=5% -2%) to 1% (=10% 9%), which has increased the likelihood that people will do so. Thus, even if mortgage rates have increased, the actual cost of financing a home is reduced. (If tax deductions for interest payments are permitted, then the likelihood that individuals will purchase homes increases.)

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